In a recent post on this page, I pointed out that even while the unemployment rate falls to within spitting distance of the Federal Reserve’s full employment rate (the lowest they think unemployment can fall without setting off rising inflation), neither wages nor prices have accelerated.
One is reminded of the classic passage from Sherlock Holmes:
Scotland Yard detective: “Is there any other point to which you would wish to draw my attention?”
Holmes: “To the curious incident of the dog in the night-time.”
Scotland Yard guy: “The dog did nothing in the night-time.”
Holmes: “That was the curious incident.”
As Holmes was guided by evidence of what didn’t happen, so must we ask why nominal wage and price growth remain flat even as the unemployment rate is telling us we’re just about at full employment. I can think of three reasons.
One, the “full-employment unemployment rate,” or FEUR, is lower than we think. Two, we are mis-measuring labor market slack. Three, economists fundamentally misunderstand these dynamics; i.e., we’re working off of historical correlations to which the data no longer conform.
I’ve written extensively about #1 (here and here with Dean Baker). Both the Congressional Budget Office and the Fed think the FEUR is about 5.4 percent. I’ve argued that that’s too high, and I suspect they’ll both have to mark it down, given recent developments. More important, like all such guesswork in economics, we should remember that there’s a numerous-percentage-point range of uncertainty around this number.
Point #2 is what I’d like to talk about today. There are times when the unemployment rate is not up to the task of capturing the true amount of slack in the labor market. It counts only as unemployed people actively seeking work, so if discouraged job-seekers give up looking, it paradoxically falls.
It also is not designed to capture part-time workers who would prefer to be working full time, thus leaving out millions of workers — 6.8 million last month, to be precise — who are “underemployed.”
None of this is meant to impugn the Bureau of Labor Statistics, one of the government’s most efficient and effective agencies. It’s all just definitional. And a few years ago, to help fill some of these holes, the bureau introduced a broader measure of labor demand, the famous U-6, currently at 11.3 percent, which includes involuntary part-timers. U-6, however, is tough to compare with FEUR, in part because it equally weights involuntary part-time and unemployed workers.
What’s needed is a measure that’s comparable to the FEUR, yet adjusts for those who exited the weak-demand-driven labor force and the involuntary part-timers. Thankfully, economist Andy Levin derived just such a metric.
His measure generates a “total employment gap” that is simply the number of percentage points we’re away from full employment (so a “0%” means no slack). It has three components. One, the difference between the unemployment rate and CBO’s estimate of the FEUR (already, there’s a problem; I’ve already told you that measure is too high). Two, the labor force participation gap, a measure designed to capture the part of the decline in the labor force due to exiters who are missing from the workforce vs. legitimate retirees. And three, the underemployment gap, which tracks the change in the percentage of involuntary part-timers, tweaked to account for how many fewer hours they’re working compared with full-timers.
The graph above is set up so that zero equals full employment by three measures: the unemployment rate, the Levin measure, and the Levin measure adjusted for a more realistically lower FEUR of 4.3 percent recently estimated by economist Allen Sinai. All three measures show the job market is tightening, and at a healthy clip. But the standard measure shows we’ve already squeezed almost all the slack out of the job market, an observation clearly belied by wage and price measures.
The other two measures say we’re not there yet, with my preferred measure — the one that uses the lower FEUR —showing we’re still a sizable two percentage points away from full employment.
This week only, I’m running a special on these measures, and they’re available free of charge to anyone who wants to use them, especially if you control a key interest rate that’s currently sitting at zero, which is where it should stay if we want working people to finally start to see some of the benefits of what everyone keeps telling them is a really great recovery.
Last point: Above, I noted three points we glean from the non-barking dog. The third, “economists fundamentally misunderstand these dynamics,” is the most interesting, and as far as policy is concerned, the most portentous. I will thus revisit it shortly.